Portfolio Review

9/14/2009


EU probe to delay Oracle purchase

The European Union will take a closer look at Oracle’s ($22; ORCL) proposed $7.4 billion takeover of Sun Microsystems ($9; JAVA), sidetracking Oracle’s goal of completing the acquisition in August. European regulators’ review could last until Jan. 19.

The U.S. has already cleared the deal, and an EU veto is not expected. But the delay, combined with uncertainty over Oracle’s plans regarding Sun’s hardware unit, leaves Sun vulnerable to customer and employee defections. Since the deal’s April announcement, IBM ($117; IBM), Hewlett-Packard ($45; HPQ), and Dell ($16; DELL) have been poaching Sun’s customers with discounts and other incentives.

Reflecting these challenges, Sun’s server sales slid 37% in the June quarter, worse than the industry’s 30% decline. Oracle and H-P are both rated Buy and Long-Term Buy. IBM is a Focus List Buy and a Long-Term Buy. Sun Microsystems and Dell are rated Neutral.

Court rules for Biogen in dispute with Elan, J&J

A federal judge ruled Elan’s ($8; ELN) $1.5 billion deal with Johnson & Johnson ($61; JNJ) violated terms of a pre-existing partnership agreement with Biogen Idec ($51; BIIB) regarding multiple-sclerosis drug Tysabri. Elan appears to have given J&J its option to acquire Biogen’s 50% stake in Tysabri if Biogen undergoes a change in control. Biogen possesses a similar option should Elan be purchased. In J&J’s hands, the option would narrow the field of perspective suitors for Biogen. Elan and J&J are scrambling to revise the terms of their deal, as the court said Elan would lose its 50% interest in Tysabri if it doesn’t fix the breach of contract by Sept. 26.

In other news, Facet Biotech ($16; FACT) rejected Biogen’s takeover bid of $14.50 per share, or about $355 million. Facet, which has several intriguing biotech drugs in development, is unprofitable but holds $253 million in net cash. Biogen reiterated its offer, but Facet shares have risen above the proposed takeover price, suggesting the market expects Biogen to sweeten its bid. Facet’s drug pipeline is geared toward multiple sclerosis and solid tumors. J&J and Biogen are rated Focus List Buy and Long-Term Buy.

Corporate roundup

Its $16.7 billion merger bid rebuffed, Kraft ($26; KFT) remains intent on acquiring Cadbury ($52; CBY), the world’s second-largest candy and chocolate maker. Kraft said it wants to keep the takeover friendly. The initial offer represented a 31% premium to Cadbury’s closing price prior to the announcement, but shares have surged even higher on the news. The British confectioner could attract interest from Nestle, Hershey ($39; HSY), Kellogg ($48; K), or PepsiCo ($58; PEP), potentially pushing bids north of $20 billion. Kraft, PepsiCo, and Kellogg are rated Neutral.

A federal appeals court granted Microsoft’s ($25; MSFT) request to delay a permanent injunction that banned the company from selling popular word-processing software Word. Microsoft plans to appeal the ban. In other news, a team of rivals is acquiring 22 patents once owned by Microsoft in an effort to head off legal threats against Linux. A free operating system, Linux has gained popularity as an alternative to Microsoft’s Windows software. Securing the patents should keep them out of the hands of companies that exist primarily to sue over patent violations. Microsoft is a Long-Term Buy.

IBM ($117; IBM) confirmed that it expects to earn at least $9.70 per share this year, compared to the consensus estimate of $9.76. The company added that it remains “well ahead” of its 2010 target of per-share profits between $10 and $11, versus the consensus of $10.68. IBM is a Focus List Buy and a Long-Term Buy.

Chevron’s ($70; CVX) $27 billion lawsuit in Ecuador took a strange turn when the oil giant submitted e-mail and video evidence that allegedly shows the judge assigned to the case discussing a bribe from a representative of Ecuador’s ruling party. The judge has recused himself from the case. Plaintiffs have accused Texaco, acquired by Chevron in 2001, of dumping polluted water into the jungle in the 1970s. Chevron says it will not pay if it loses the case. Chevron is a Long-Term Buy.

Retail sales fall, but not as fast

Accounting for about 70% of U.S. economic activity, consumer spending keeps burrowing lower, though it has slowed to a shovel’s pace rather than a jackhammer’s. U.S. chain-store sales (excluding results from Wal-Mart Stores ($51; WMT), which does not report monthly data) dipped 2% in August, the smallest decline since last September 2008. Department stores struggled with a 7.3% sales decline, though drugstores and wholesale clubs managed modest gains. The performance could have been worse. Among the 30 retailers tracked by Thompson Reuters, same-store sales dropped 2.9%, less than the consensus estimate of 3.8%. However, results from this group were mixed, with 50% of the retailers falling short of analyst expectations. Wal-Mart Stores is a Long-Term Buy.

News digest

Cognizant Technology Solutions ($36; CTSH) acquired Pepperweed Advisors to augment its technology-infrastructure services. Terms were not disclosed. Cognizant, which rallied to 52-week highs Sept. 8 after the company said demand trends remain positive, is a Focus List Buy and a Long-Term Buy.

Oceaneering International ($57; OII) announced that it won a three-year, $45 million contract to provide onshore and offshore maintenance for BP ($54; BP). Oceaneering is a Focus List Buy. BP is a Neutral.

Verizon Communications ($31; VZ) raised its quarterly dividend 3% to $0.475, payable Nov. 2. Verizon is rated Neutral.

In search of growth? Look deep

From possibly the deepest well ever drilled, BP ($54; BP) discovered a major oil reserve in the Gulf of Mexico using one of Transocean’s ($80; RIG) ultra-deepwater rigs. The find underscores the strength of deepwater projects in an otherwise moribund industry.

New technology has helped drive a rash of discoveries in ancient rock far below the seafloor in the Gulf of Mexico and off the coast of Africa. The projects are expensive, with each well costing about $200 million to drill. That cost does not include the pipelines and other equipment and supplies used to pump out the oil. Companies such as Oceaneering International ($57; OII) and Schlumberger ($58; SLB) supply such equipment.

In shallower waters, the situation is different. One client paid Transocean an early termination fee to end a midwater project two months early. That floating rig now sits idle. Transocean has idled several shallow-water rigs, and day rates for such jack-ups are on the decline. Four of Transocean’s jack-ups are entering new contracts at rates 34% below their last deals. And a midwater rig has begun work on a project at a daily contract rate of $300,000, well short of the $450,000 it generated from its last gig.

However, the Forecasts’ top energy selections are heavily leveraged to deepwater drilling. In August, Transocean announced a new contract for an ultra-deepwater rig at an average day rate of $530,000, almost triple the rig’s previous contract for a project started in June 2005. In August, Chevron ($70; CVX) started a five-year project on one of Transocean’s newly completed ultra-deepwater drillships at a day rate of $469,000 for the first three years. About 80% of Transocean’s contract backlog reflects deepwater projects.

About 88% of rig builder and outfitter National Oilwell Varco’s ($38; NOV) $8.7 billion backlog is leveraged to offshore operations. And Oceaneering sells a variety of products designed for deepwater environments. Transocean is a Focus List Buy and a Long-Term Buy. Oceaneering is a Focus List Buy. National Oilwell is a Buy and a Long-Term Buy. Schlumberger and Chevron are Long-Term Buys. BP is rated Neutral.

  RANK CHANGES
No changes were made this week in Dow Theory Forecasts.

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